Creating Generational Wealth

by | Aug 27, 2019 | Finances, Investments, Passive Income, Real Estate, Tax Deferral

Did you know? McDonald’s isn’t just a fast-food chain—it’s a brilliant $138 billion real-estate company. But rather than collect a lot in royalties or sell its franchisees cooking equipment, McDonald’s makes much of its revenue by buying the physical properties and then leasing them to franchisees, often at large mark-ups! What Ray Kroc created was not a burger business but a real estate business.

How the Wealthy Invest

The wealthy invest in real estate not just to grow their money and fund a comfortable retirement but to create generational wealth – a legacy that multiple generations after them can carry forward.

Traditional finance advisors incentivized by Wall Street have peddled out advice to do the 80%/20% stocks/bonds and alternatives split which is adjusted with risk tolerance and age. The idea is that, as you get older you reduce your stock exposure which is riskier and increase the bond exposure and live with 3-4% returns which doesn’t even keep pace with inflation not to mention all the fees that most large institutions charge on their offerings. The result is with all the market cycles you spend a good deal of time recovering from the dips in the cycle rather than growing your capital.

I recently attended a Financial Services conference where a brilliant financier and Harvard lecturer Thomas Powell spoke about how the wealthy invest (based on a joint study conduct by Harvard and Yale University) . While most advisors recommend 70-80% in stocks and bonds the wealthy have 40% or less in stocks/bonds and 60% in alternative investments – real estate, oil and gas among others.

Why Multifamily Real Estate?

Real estate investments not only provide appreciation over time but also provide enormous depreciation benefits. Although the real estate market is cyclical like any other, there are asset classes within real estate that are inherently more stable and tend to hold value better than others through downturns. These can be relatively stable as long as they are underwritten conservatively. Multifamily tends to be one such asset class.

Housing is not a discretionary expense. People need a place to live regardless of market cycles. As long as multifamily assets are purchased in good locations with solid cashflow and conservative underwriting I believe that they make strong recession resistant assets that allow your money to grow to make money even through downturns.

In 2008 the Phoenix market the single family market dipped considerably and lost about 20-40% in value. In contrast the cap rate spread for Multifamily investments looked like below.

Average Cap rates in the Phoenix market over the last 14 years (Ref: Cushman & Wakefield Marketbeat report)

The blue indicates the average cap rate which is the low 5 range now and the cap rate in one of the worst recessions in 2008 was in the low 7’s. The spread was 2% between the highest and lowest times of the market cycle. While increasing cap rates does mean decreasing value as long as these properties stay occupied and cashflow they don’t hurt like single family investments. Taking into account the change in cap rates when underwriting also helps us mitigate risks and be more conservative with our projections. Overall multifamily investments hold out well through recessions. As long as they are bought in good locations with good cashflow, one can create value with forced appreciation – increasing rents and reducing expenses and hold it through a potential downturn.

Retirement Accounts and Real Estate

Retirement Accounts and Real Estate Investments are a perfect duo. In talking to investors, I find that retirement accounts are the underutilized and underinvested asset they have. Since real estate doesn’t have liquidity and neither do retirement accounts this is the logical starting point for most investors to turn to for investing in real estate. It’s a perfect marriage.

Most people have no idea

  1. What their retirement accounts are doing or how to invest them well. Most retirement accounts that are invested in “retire in 2040” fund that might be barely keeping up with inflation.
  2. That they can make real estate investments through their retirement accounts using Self Directed IRA, QRPs and Solo 401(K)s even as a W-2/full-time employee.
  3. That they can dip into their Employer 401K to do self directed investments even without changing jobs in some cases.

Fast Tracking Retirement and building generational Wealth

Traditional advice leads to traditional results. Retire at 65 and just maybe you will be able to afford enough cashflow to pay the expensive medical bills. What about that travel plans you have when you retire? Well maybe you can’t travel so much after all with your arthritis bothering you :-/ Never mind that we can’t even bank on any social security income in 10-20 years.

Retirement is no longer that elusive goal which happens at 65. There are increasingly a large number of people choosing to retire in their 30s and 40s and follow their passions when they are able bodied and healthy enough to do so.

So how can you fast track your way to retirement?

Invest like the wealthy do. Don’t invest to make a quick buck in the market. Create passive income. Invest in real estate and other alternatives that provide depreciation. Collect the depreciation to offset the gains and pay no taxes. Use the cashflow to save and invest into more assets if you don’t immediately need the cash.

Uncle Sam takes a big bite out of your stock market earnings but with alternative investments like real estate you can offset gains with depreciation allowing your money to grow tax-free. Strategies like refinancing can allow you to take equity distributions without the tax implications further making for tax free income. 1031 exchanges can help you rollover proceeds from one property to another when you’ve exhausted the growth in one or you have too much equity in one. There are just so many options.

So how do you offset your stock market gains? With real estate investments in Opportunity Zones of course! Check out my linked article on Opportunity zone investments to save on your stock, crypto or any other capital gains you might have created.

Real estate needs to be a necessary ingredient of every investor’s portfolio. Let’s be honest. Real estate rocks!

It’s AS simple as that.